Contraction flexibility,operating leverage,and financial leverage |
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Affiliation: | 1. School of Management and Economics, University of Electronic Science and Technology of China, Chengdu, 611731, China;2. Post-Doctoral Scientific Research Workstation, Chongqing Airport Group Co., Ltd, Chongqing, 401120, China;3. School of Economics and Business Administration, Chongqing University, Chongqing, 400044, China |
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Abstract: | This study investigates the impacts of contraction flexibility and operating leverage on financial leverage from the perspective of the agency conflict between shareholders and debtholders. In a continuous-time real option framework, we demonstrate that shareholders’ contraction flexibility may have an adverse effect on financial leverage, and that the substitution relation between operating leverage and financial leverage is persistent or pronounced in the presence of contraction flexibility. The evidence from Chinese listed firms not only supports our theoretical predictions well, but also offers a method to examine the agency conflict hypothesis. We suggest that the high proportion of bank loans or long-term debt in total liabilities can help levered firms alleviate the agency problem arising from contraction decisions. |
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Keywords: | Contraction flexibility Financial leverage Agency conflict Operating leverage |
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